Pegasus Airlines: one of Europe's most profitable airlines returns to improving profitability trend

Analysis

After four successive quarters of year on year declines in its underlying operating result, Pegasus Airlines reported an increase in 3Q2014. Its operating margin was at the same level as 3Q2013, after falling in 1H, and second in Europe only to Ryanair (of those to report thus far).

As always, Pegasus' results are complicated by foreign exchange, especially as Turkey's currency has weakened against EUR and USD. Expressed in its functional currency of EUR, rather than its reporting currency of TRY, Pegasus' CASK (cost per available seat km) edged up slightly in 3Q, reversing the decline of 1H. Fortunately, RASK (revenue per available seat km) also increased at a similar rate, ending a four quarter falling trend. This was helped by a relative slowing of its capacity growth in addition to less aggressive pricing by Turkish Airlines at Sabiha Gökçen.

Pegasus has reiterated its FY2014 guidance, although there now seems to be scope for it to do better. Our suggestion after 2Q results, that Pegasus may have turned a corner and be ready to leave the path of deteriorating margins, seems to be gaining credibility.

In 3Q2014, Pegasus more than doubled its net profit to TRY252 million (EUR88 million) from TRY115 million in the same period a year earlier, boosted by favourable exchange rate movements and lower net financial charges. The improvement in the underlying profitability was less pronounced. Operating profit (before other operating income/expenses) grew by 33% to TRY293 million (EUR102 million).

Revenue growth was also 3% and the operating margin was stable at 26.4%. The gain in underlying operating profit in 3Q2014 was not enough to offset the deterioration in the 1H2014 result and 9M2014 operating profit fell 17% year on year on TRY261 million (EUR89 million). Its 9M margin fell by 6.5 ppts to 10.8%.

Pegasus' 3Q and 9M2014 operating margins place it above the Big Three European legacy groups, its local rival Turkish Airlines and Aer Lingus. Among the major European airlines that have reported for the period, only Ryanair had higher margins than Pegasus.

Note: margins calculated as pre-exceptional operating profit as a percentage of revenue
*Ryanair's financial year end is Mar; chart shows results based on calendar year periods
Source: CAPA - Centre for Aviation, company reports

ASKs were up 18%

Pegasus increased total ASKs by 18% in 3Q2014, with load factor just below flat at 82.7% (-0.1ppts). This capacity growth was slower than the 24.8% rate in 1H2014 and 9M ASK growth was 22.0%.

Pegasus' 9M load factor of 80.6%, flat on last year, is closer to the levels recorded by full service carriers than it is to the higher levels enjoyed by Europe's main LCCs. Pegasus' load factor performance has been slightly better on its domestic network (where capacity growth has also been a little slower) than on its international network.

Revenue rose 33%

Pegasus' 3Q revenue growth of 33%, faster than ASK growth, was mainly driven by a 32% increase in scheduled flight revenues, boosted by a 55% increase in ancillary revenues, but slowed by growth of only 14% in charter revenues. Ancillary revenue per passenger increase by 35% to TRY26, or in EUR terms, by 23% to EUR9.

Scheduled revenues were propelled largely by international flights, where revenue growth was 37%. This international revenue growth compares favourably with international ASK growth of 18.5%, although it was helped by the strengthening of EUR against TRY. In EUR terms, Pegasus' international network still generated unit revenue growth of around 7%.

Domestic flight revenues grew by 24%, compared with ASK growth of 17.1%. Previous price weakness at Sabiha Gökçen (SAW), cased by Turkish Airlines' rapid expansion and introductory pricing at the airport, has eased following the competitor's return to more normal pricing.

According to our calculations, total revenue per ASK (RASK) grew by 12.5% year on year, boosted by a fall in the value of TRY against international currencies. Converting to EUR at average exchange rates for both 3Q2014 and 3Q2013, the increase in RASK was 2.3%.

Turkish Airlines entered SAW in order to increase its growth options as its main hub at Istanbul Ataturk became more congested. Even after the opening of the planned new Istanbul airport, Turkish is likely to maintain a significant presence at SAW.

Indeed, THY CEO Temel Kotil recently said “We will establish a permanent fleet in the Sabiha Gökçen Airport of Istanbul. We’ll be transferring our 100 airplanes to the Sabiha Gökçen from our main base in the third airport, which will still have 300 THY airplanes” (Hurriyet Daily News, 11-Nov-2014).

Pegasus' lower cost structure and different route network focus should allow Turkey's two largest carriers to co-exist at SAW. As Pegasus CEO Sertac Haybat told analysts on a conference call to discuss the 3Q results, "whatever Turkish Airlines' presence is in Sabiha Gökçen, the important thing is as long as we keep the CASK difference, we do not have anything to worry about."

Costs up 33%, same as revenue

Operating costs grew by 33%, the same rate as revenue growth, with fuel costs up 31% and non-fuel costs up 34% in 3Q2014. We calculate that CASK grew by 12.5% and ex fuel CASK by 13.9%. Weakness of TRY against EUR and USD increased the rate of CASK growth. In EUR terms, unit cost growth was more modest, with CASK up 2.4% ex fuel CASK up 3.6%.

FY2014 guidance looks conservative

The 3Q2014 operating result (before other operating income/expenses) was the first quarter in four to be higher than that reported for the same period a year earlier albeit at the same margin. This is because it was also the first quarter in this time when RASK growth matched CASK growth.

Pegasus Airlines year on year change in EUR-denominated RASK and CASK 1Q2013 to 3Q2014

Pegasus has modestly trimmed its FY2014 target for growth in passengers (and ASKs) from 20% to 18% but is still targeting an EBITDAR margin in the range 17% to 19% (versus 22% in 2013). This guidance implies year on year growth in EBITDAR in absolute terms (albeit at a lower margin) in FY2014 and in 4Q2014. After falling in 1H2014, EBITDAR increased by 9% in 9M2014, although the 9M margin was down 5ppts to 21.6%, and should be higher for the full year.

However, disproportionate increases in depreciation and operating lease rentals mean that the 2014 operating profit will likely be lower than in 2013. The EBITDAR guidance also suggests that the 4Q2014 operating loss may be wider than in 4Q2013 (before other operating income/expenses). The latter point would mean that 3Q's out-performance of RASK against CASK growth would again be reversed in 4Q.

Pegasus is one of only three ultra low cost airlines in Europe and the only one with a significant presence in Turkey. The more stable yield outlook and likely benefit to the cost base from the fall in oil prices, should enable Pegasus to improve on its FY2014 target.

Want More Analysis Like This?

CAPA Membership provides access to all news and analysis on the site, along with access to many areas of our comprehensive databases and toolsets.